Why do the nouveau riche flaunt their wealth, while the old rich
scorn such gauche displays? Why do mediocre students often outperform talented students? Why are moderate quality goods advertised
heavily, while high-quality goods rely on their reputation? Why do minor
officials prove their status through petty displays of authority,
while the truly powerful prove their strength by avoiding such displays?

To understand how people can show off by not showing off, we return to
Veblen's 1899 analysis of conspicuous consumption. Veblen argued that boasting about one's riches or
spending money wisely is not enough to prove that one is rich - one must spend money on luxury goods
or other wasteful activities. Spence's 1973 model of
signaling
formalized this argument by showing that
wasteful actions can separate higher "quality" types from lower quality types if the action is less burdensome
to the higher quality types. Spence's model quickly became a foundation of economic theory, used to
explain behavior from advertising to financial structure. Zahavi's 1975 model of handicapped signaling (see
his new book)
showed how reasoning similar to that of conspicuous consumption can explain a wide range of animal traits and behavior.
Features such as a peacock's elaborate
plumage may handicap an animal, but nevertheless benefit it by proving to potential mates, rivals,
or predators its ability to bear the burden. Grafen formalized this concept in 1990, showing that conditions
similar to Spence's also apply to biology signaling models.

While these models explain showing off through wasteful "signals", they do not
consider the opposing behavior of deliberately avoiding such displays so as to "countersignal" that
one is above playing such games. We develop a theoretical model in which the signal is not the only information
available to those judging the quality of the sender. For instance, wealth is inferred not
just from conspicuous consumption, but also from information about
occupation and family background. This extra information is likely
to be only partially informative, meaning that types of medium
quality may still feel compelled to signal so as to separate
themselves from low types. But even noisy information will often
be sufficient to adequately separate high types from low types,
leaving high types more concerned with separating themselves from
medium types. Since medium types are signaling to differentiate
themselves from low types, high types may choose to not signal, or
countersignal, to differentiate themselves from medium
types.

While it might
seem that the sender is just saving signaling costs by not signaling,
we show that countersignaling can be interpreted as a signal of confidence
that the extra information about the sender is favorable.
This reverse signaling can invert a number of the standard
implications of signaling models. Whereas signaling equilibria can
be inefficient because of excessive signaling, countersignaling
equilibria may be inefficient because of inadequate signaling.
While signaling equilibria can play an informational role in
increasing the efficiency of receiver estimates of type,
countersignaling equilibria may lower the efficiency of these
estimates. And while higher costs tend to reduce signaling in a
signaling model, a limited increase in costs can lead to more
signaling in a countersignaling model.

To offer further insight into this issue we report on an economic
experiment conducted in 1995 to test the theory. The
experimental results confirm that adding noisy exogenous
information on types to signaling games can affect behavior in
directions consistent with the predictions of countersignaling
theory. Countersignaling was rare in the cell of the
experiment where extra information on sender type was unavailable.
But in the cell where such information was included countersignaling
was the most common choice by the last period of the experiment.

Signal failure?

The economics of understatement

ECONOMISTS have long been obsessed with signals. Slogging through an MBA course, for example, might not raise your productivity, but the mere fact that you bothered to do so - and paid thousands for the privilege - tells employers something about you. People of above average ability want to show that they are a cut above the riff-raff, and are willing to pay for it.

So far, so simple. But signalling theory copes badly with real-word nuances. How can economists explain the confused or even false signals people often send? Some university hopefuls like to dress like urban gangsters. The best companies sometimes prefer discretion to shouting about their merits, or even delay their results. Isn't this irrational, and further evidence of the uselessness of economic theory?

Not according to a recent article* in the RAND Journal of Economics , which argues that such behaviour is readily explicable. Rather than assume (as most signalling models do) that there are just two classes of people - above and below average - the authors start with three categories: high, medium and low ability. "Countersignalling" - pretending to be less bright than they really are - is then one way in which people of high ability can set themselves apart from the merely middling.

Suppose that a mixture of people apply for a job. Interviewers have two sources of information about their quality: exam grades and a personal recommendation. Because these are imperfect signals, middle-ability applicants might be confused with either high-ability or low-ability types. To distinguish themselves from the dross, they boast about their grades. The high-quality people, however, know that their grades and references will distinguish them from those of low ability. By not bothering to mention their grades, they set themselves apart from the middle group as well. The authors back up their theory with classroom experiments.

Countersignalling, say the authors, can explain why mediocre students are keen to answer a teacher's easy questions, while the best students are embarrassed even to bother raising their hands, and why minor, insecure managers are obsessed with displays of power. The trouble now is that those of middle rank are sure to grasp the idea. What will high-flyers do next to distinguish themselves? Expect soon the theory of counter-counter signalling.